Heading into this week, I want to make sure I am prepared for the big CPI data release on Tuesday. The important thing I want to do is not so much make a prediction, but be weary of multiple outcomes and how the market reacts to those outcomes.
Let's Look at the Last Few Months of CPI Data. The Topline Data means all of the items in the report on a year over year basis. The CPI Core data excludes food and energy:
- July 2022 (Released August 2022) - Topline Number was 8.5%. CPI Core was 5.9%.
- June 2022 (Released July 2022) - Topline Number was 9.1%. CPI Core was 5.9%.
- May 2022 (Released June 2022) - Topline Number was 8.6%. CPI Core was 6.0%.
- April 2022 (Released May 2022) - Topline Number was 8.3%. CPI Core was 6.2%.
- March 2022 (Released April 2022) - Topline Number was 8.5%. CPI Core rate was 6.5%.
- Feb 2022 (Released March 2022) - Topline Number was 7.9%. CPI Core rate was 6.4%.
- Jan 2022 (Released Feb 2022) - Topline Number was 7.5%. CPI Core rate was 6.0%.
Below is how the market reacted to the data above:
- The March 2022 data to April 2022 data saw the first decline on both the Topline and Core for the first time in 2022. This brought the hope that inflation could be peaking, and slowing down.
- The May 2022 data release (Released June 2022) saw not only an increase from the previous month, but a Topline number higher than the March 2022 data. This caused the market to hit new lows.
- The June 2022 data release (Released July 2022) saw a hotter than expected read and the market gapped down 6 points and proceeded to recover most of that loss that day and started an upward trend (July 13th on the charts)
- The July 2022 data release (Released August 2022) saw a cooler read on the top line and sticky core number. This was at the height of the Fed pivot theory and the inflation report backed up that the theory still had a possibility. This caused the market to maintain an uptrend that ultimately led the SPY to test 430 a week later.
Now let's look ahead to the reporting coming out on Tuesday, September 13th.
- The estimate for the Topline is 8.1%. The Core is 6.1%.
- So we have a lower estimate on the topline and the core is expected to go up. Tricky, tricky...
Here are the scenarios we are watching for:
- Scenario 1 - CPI comes in above expectations, 8.5%+ on the topline and Core comes in at expectations over 6%
- Bullish Argument - The argument can be made that inflation has peaked and we are still not setting new highs. So this "sticky" inflation does not make the Fed more aggressive, they just stick to the plan of continuing raising rates.
- Bearish Argument - This shows that the Fed's actions have not been able to control inflation and with Core going up, this confirms a current stagflaltion. This should lead to a move downward in the market and a retest of 400 at the time of the data release.
- Scenario 2 - CPI comes in above expectations on the topline, but flat or down on the Core:
- Bullish Argument - Core not going up means we are actually seeing results in the Fed's actions and we should see a continued decrease in inflation as long as they continue to raise rates steadily. The rise in the topline could be contributed to international commodity supply issues, which are starting to cool.
- Bearish Argument - This is a weak argument to make, but the fact that headline is going up means that the nature of inflation is still out of control and unpredictable. Thus creating a difficult timeline for the Fed to really knowing when to stop being aggressive.
- Scenario 3 - CPI comes in flat at expectations on the Topline and Core:
- Bullish Argument - Though the number is greater than the previous month on core, it was expected. Topline coming in at expectations actually sees a decrease from the previous month. This creates the same argument that inflation is sticking and has peaked on the topline.
- Bearish Argument - Same bearish argument from Scenario #2 as above with the reading being unreliable.
- Scenario 4 - CPI comes in below expectations on the Topline and Core:
- Bullish Argument - Inflation is starting to peak and the Fed's actions are starting to work faster than the market's expectations. Buy calls and enjoy the week.
- Bearish Argument - None.
How I am looking to play the data release based on the scenarios:
- Short Term Plays
- Scenario 1, 2 or 3 - Stay on the sidelines and enter to play day to day levels. Can't be married to one side on this result as the bearish argument is not as valid as the bullish one.
- Scenario 4 - Buy calls for a few weeks out as the SPY will retest 415-420 levels.
How will the Fed React?:
- Scenario 1, 2 and 3 confirms a 75 BPS hike in September meeting.
- Scenario 4 opens the door to do a 50 BPS hike in the September meeting and again a possibility to pause hikes after the October meeting to see if inflation can start trending downward.
Thanks for reading through this data dump of thoughts by me. Should be an interesting week ahead.
All the statements in this report are my own and not financial advice.